David Cameron suffered an embarrassing defeat on Tuesday night after the House
of Lords voted to bring in new press laws against the wishes of the
Government.

In a surprise move, peers passed an amendment to the Defamation Bill to introduce a cheap arbitration service between newspapers and people who feel wronged by the press – one of Lord Justice Leveson’s key recommendations.

The amendment raises the possibility that some of Lord Justice Leveson's most controversial proposals could become law by the backdoor.

It means the Prime Minister will now have to persuade MPs to overturn the planned legislation in the House of Commons or accept the Lords amendment.

The Government described the vote as “disappointing” as Mr Cameron opposes statutory regulation of newspapers and wants get cross-party consensus for an independent watchdog.

Sources on Tuesday night suggested they are confident of overturning the amendment and finding an agreement in cross-party talks.

However, Mr Cameron may not find it straightforward to get a majority to throw out the new legislation as Labour and the Liberal Democrats fully support Lord Justice Leveson’s proposals.

The Conservatives are hoping that the Liberal Democrats will agree to a Royal Charter in cross-party talks as a compromise, evens though Nick Clegg, the deputy Prime Minister, wants the Leveson Report to be fully implemented. Lib Dem sources said it is much too early to talk about the Lords amendment while those talks are continuing.

The defeat appeared to take the Government by surprise as MPs debated gay marriage and Mr Cameron held meetings with US vice president Joe Biden.

Around 12 Conservatives, including Lord Mackay, a former Lord Chancellor, Lord Ashcroft, a major donor, and Lord Hurd, the former Foreign Secretary, joined the rebels, who won by a margin of 131.

Under the amendment, it would be voluntary for newspapers to join the arbitration service but failure to take part could see them hit with damages claims in the courts.

Sources close to the Conservatives said the defeat will not make much difference because Mr Cameron and Maria Miller, the Culture Secretary, hope on-going cross-party talks will succeed.

Lord McNally, a Liberal Democrat peer speaking for the Government, said Conservative proposals to establish a press watchdog under Royal Charter will be published next week. This will then be examined by all parties.

Unless the legislation is overturned, it would become law when the Defamation Bill gets royal assent. Otherwise, the Government could take the radical step of withdrawing the Bill in its entirety. Alternatively, it could accept the amendment.

The prospect of giving MPs a vote on part of the Leveson Report threatens to de-stabilise the cross-party talks, which have been dragging on for almost eight weeks.

Some MPs campaigning for tougher press laws and pressure groups have been agitating for a quicker solution.

Lord Puttnam, a film producer who helped propose the amendment, said it “offers us the opportunity to break the logjam that appears to have afflicted both the talks between newspapers and the Government and the talks between the three main political parties themselves”.

"At the very minimum we would have the opportunity to make justice in disputes with newspapers quick and affordable,” he said.

The Archbishop of York, Dr John Sentamu, backed the amendments as a way of helping to restore "trust" in the media.

He added: "Do we think in this defamation area that only the rich should have redress? The press ought to be welcoming it because costs may be far, far less than going through a very elaborate court case."

Lord Fowler, a Tory former Cabinet minister, backed the move as a "building block in implementing Leveson - a kind of stalking horse".

A spokesman for the Department of Culture, Media and Sport, said: "This is not government policy and we are disappointed the House of Lords has agreed to this amendment, which is a flawed attempt to implement the Leveson principles.

"The amendment would have to return to the Commons and the view of the Culture Secretary remains the same - statutory underpinning is not necessary for tough self independent press regulation. All the main political parties have agreed that a cross-party approach is best, and these talks are on-going."